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Predicting Economic Activity with Financial Market Data in a Small Open Economy: Revisiting Stylized Facts During Economic Turbulence

Petri Kuosmanen and Juuso Vataja

A chapter in Macroeconomic Analysis and International Finance, 2014, vol. 23, pp 217-234 from Emerald Publishing Ltd

Abstract: Abstract Purpose This paper examines the predictive content of financial variables above and beyond past GDP growth in a small open economy in the Eurozone. We aim to clarify potential differences in forecasting economic activity during periods of steady growth and economic turbulence. Design/methodology/approach The out-of-sample forecasting analysis is conducted recursively for two different time periods: the steady growth period from 2004:1 to 2007:4 and the financial crisis period from 2008:1 to 2011:2. Findings Our results from Finland suggest that the proper choice of forecasting variables relates to general economic conditions. During steady economic growth, the preferable financial indicator is the short-term interest rate combined with past growth. However, during economic turbulence, the traditional term spread and stock returns are more important in forecasting GDP growth. Research limitations/implications The results highlight the importance of long-term interest rates in determining the level of the term spread when the central bank implements a zero interest rate policy. Moreover, during economic turbulence, stock markets are able to signal the expected effects of unconventional monetary policy on GDP growth.

Keywords: Term spread; short-term interest rate; stock market; forecasting; macroeconomy; E37; E44; E47 (search for similar items in EconPapers)
Date: 2014
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